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Law of Supply and Demand

Defined
David Luther | Digital Content Strategist
July 14, 2022

You're about to launch a new product, but you aren't sure how
much to produce or how much to charge. Price it too high or
make too much of it, and you could be left with unsold stock. If
you price too low or don't make enough, you'll lose potential
profit. Everything depends on the demand for the product —
how much customers will buy at what price. That's why the law of
supply and demand is so relevant to business decisions. It
predicts the relationship between supply, demand and pricing.
Understanding the law of supply and demand can help
businesses meet customer demand while maintaining healthy
profits and minimizing excess stock.

What Is the Law of Supply and

Demand?
The law of supply and demand is the theory that prices are
determined by the relationship
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NetSuite If
ERP. Top
the supply of a good or service outstrips the demand for it, prices
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will fall. If demand exceeds supply, prices will rise.

The law of supply and demand is based on two other economic

laws: the law of supply and the law of demand. The law of supply
says that when prices rise, companies see more profit potential
and increase the supply of goods and services. The law of
demand states that as prices rise, customers buy less.

Theoretically, a free market will move toward an equilibrium

quantity and price where supply and demand intersect. At that
point, supply exactly matches the demand — suppliers produce
just enough of a good or service, at the right price, to satisfy
everyone's demands.

Key Takeaways
The law of supply and demand predicts that if the supply of
goods or services outstrips demand, prices will fall. If
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 demand exceeds supply, prices will rise.
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In a free market, the equilibrium price is the price at which
the supply exactly matches the demand.
Understanding the law of supply and demand helps
businesses determine how to set prices and fulfill customer
demand while minimizing excess inventory.

Law of Supply and Demand

Explained
The law of supply and demand describes how the relationship
between supply and demand affects prices. If a supplier wants
more money than the customer is willing to pay, items will most
likely stay on the shelf. If the price is set too low, customers will be
eager to buy the items, but each item will be less profitable. The
law of supply and demand is based on the interaction between
two separate economic laws: the law of supply and the law of
demand. Here's how they work.

The Law of Supply.

The law of supply predicts a positive relationship between pricing
and supply. As prices of goods or services rise, suppliers increase
the amount they produce — as long as the revenue generated by
each additional unit they produce is greater than the cost of
producing it. Seeing a greater potential for profits, new suppliers
may also enter the market. For example, prices of lithium and
other metals used in batteries have soared as sales of electric
vehicles have increased. That has encouraged mining companies
to explore new sources of lithium and expand production at
existing mines in order to increase the supply and generate
higher profits.

The law of supply can also operate on a local scale. Let's say a
well-known musician is coming to town. Anticipating a huge
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demand for tickets, promoters aim to maximize the supply by
booking the biggest venue possible and offering as many tickets
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as they can, at high prices. As the supply of tickets runs out, the
price of secondhand tickets rises — and so does the supply — as
casual fans who bought tickets at the list price see the
opportunity to resell them at a higher price. As a result, they
enter the market as new suppliers.

The Law of Demand.

The law of demand says that rising prices reduce demand. So as
prices rise, customers buy less. That's particularly true if they can
substitute cheaper goods. When the famous musician comes to
town, not everyone may be able to afford a ticket even if they'd
like to go. So, if the theater sets prices too high, fewer people will
decide it's a worthwhile purchase, and the show organizers will
be left with empty seats. Fans who want to resell their tickets may
need to lower their asking price. Some people may decide to see
another artist instead, if those tickets are cheaper.

The Law of Supply and Demand.

The price where supply and demand meet is known as the
equilibrium price. At that price point, suppliers produce just
enough of a good or service to satisfy demand, and everyone
who wants to purchase the product can do so. In practice, of
course, balancing supply and demand is more complex. As
supply and demand fluctuate, the equilibrium price can vary over
time. Furthermore, the law of supply and demand assumes that
all other factors that can affect pricing remain constant. In reality,
that's often not the case. For example, fluctuating production
costs or supply chain problems can have a big impact on pricing.

Why Is the Law of Supply and

Demand Important?
Business success in any competitive market depends on
accurately
No more assessing supply
wasted time and demand.
in 2024. Every
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NetSuitethat
ERP.
launches a new product needs to determine how much of the
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product to make and how much to charge. A business that 
manufactures too much of a product or sets prices higher than
customers will pay can easily find itself left with products that
don't sell and become dead stock. On the other hand,
understocking or setting prices too low reduces profits and can
drive away customers who can't wait for backorders to be fulfilled.
Demand forecasting can help businesses determine the optimal
supply level and find the equilibrium price — the price at which
the supply just meets customer demand.

4 Basic Laws of Supply and Demand

The law of supply and demand predicts four ways that changes
in either demand or supply will drive changes in pricing:

1. Prices fall when supply increases and demand

remains constant.
If supply increases without a change in demand, a surplus
usually occurs. This can happen for many reasons, including
surges in productivity. To move excess stock, especially if
there's a pending expiration date, suppliers tend to lower
prices to try to boost demand.

2. Prices fall when demand decreases and supply

remains constant.
A surplus can also occur when customers want less of a
good or service, even without a change in supply. The effect
is the same: lower prices.

3. Prices rise when supply decreases and demand

remains constant.
If supply drops, shortages occur. In that situation, customers
are often willing to pay higher prices to get the goods and
services they want. Supply constraints can occur for many
No reasons, including
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in 2024. problems.
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with problem
NetSuite is
ERP.
 temporary, prices tend to return to their baseline once
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supply is restored.
4. Prices rise when demand increases and supply
remains constant.
A shortage can occur if the demand for a product increases
but the supply doesn't — or if demand increases faster than
production can ramp up. When supply eventually catches up
with demand, prices tend to stabilize.

Inventory Price
Supply Demand Level Change

Increases Remains Surplus Lower

constant

Remains Decreases Surplus Lower

constant

Decreases Remains Shortage Higher

constant

Remains Increases Shortage Higher

constant

How changes in supply and demand affect prices and supplier inventory.

Demand Curve
A demand curve is a graph that tracks the relationship between
price (vertical axis) and demand (horizontal axis). The downward
slope indicates that when prices rise, demand tends to fall.

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The extent to which price changes affect demand varies from
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product to product. For any product, the steepness of the curve
is a measure of its demand elasticity — the extent to which
demand is affected by changes in the price. A less steep curve
indicates that a small change in price causes a large change in
demand.

Note that the demand curve only considers the effect on

demand of a single factor — price. Other factors that influence
demand, such as advertising, can shift the entire demand curve
to the left or right.

Supply Curve
A supply curve shows the relationship between price (vertical
axis) and supply (horizontal axis). It indicates how much output
suppliers are willing to produce at different prices. When a
supplier sees more profit potential from higher prices, it often will
allocate more of its resources toward those more profitable items
— usually at the expense of lower-priced items. At the same
time, newcomers may enter the market, further increasing the
available supply — because with the promise of higher revenue,
more companies may be prepared to invest the startup costs
required to enter that market.

Like demand curves, supply curves consider the effect of pricing

but assume that everything else remains constant. However,
other factors, such as production costs, can affect the supply. For
example, if rising hamburger prices are dictated by more
expensive beef, a restaurant owner may not see enough profit
from the higher prices and may not have much incentive to
expand capacity by adding another grill to the kitchen. Other
constraints, such as limits on manufacturing capacity or the
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availability of raw materials, may also negatively impact the ability
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to increase supply.

Balance Between Supply and

Demand
Understanding the balance between supply and demand is
critical in many industries. Price is a key factor in determining this
balance — although it's not the only factor. The extent to which
price affects demand depends on the type of product being sold.
It also depends on the competitiveness of the market. For some
nonessential goods or items with many available substitutes,
there will be high demand elasticity — and demand for one of
those products will be highly affected by price changes. In
contrast, demand for essential goods, like gasoline or health care,
is relatively inelastic: If someone needs gas to get to work, they
will probably pay for it no matter the price, especially if they don't
have other options, like public transit.

Many other factors can affect the balance between supply and
demand, thus impacting pricing. For example, supply can be
affected by the cost of raw materials, technology that increases
productivity, transportation or other supply chain issues, and
government regulations.

Law of Supply and Demand

Examples
The interlocking relationship between supply and demand can
be seen at all levels of the economy. Here are some current and
historical examples:
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 Sports nutrition company MusclePharm sought to grow its
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business rapidly to meet expanding demand, but challenges
included poor inventory visibility and accounting software
that lacked the scalability and scope required to meet the
company's objectives. Implementing a highly flexible,
scalable and integrated enterprise resource planning (ERP)
solution helped MusclePharm achieve 35x revenue growth
within just a few years.
Responding to rising demand, Earth-Kind created the first
all-natural indoor rodent repellent approved by the FDA.
Streamlining business operations with an integrated ERP
system helped the company maintain a 40% growth rate
and increase the supply of its products to 20,000 retail
locations.
As sales of high-end digital camera models rose during the
1990s, camera manufacturers invested in technology to
increase production and expand the available supply.
However, the resulting oversupply resulted in excess
inventory and plummeting prices. The demand for digital
cameras continued to decline as consumers switched to
alternative products — smartphones that included cameras
that were adequate for many uses.
Demand for hand sanitizer rose during the early days of the
COVID-19 pandemic. As prices rose, some companies that
saw a drop in demand for their primary products, such as
breweries, saw an opportunity. Because they had the
capability to make alcohol-based hand sanitizer, they started
doing so. This increased the market supply, helping to meet
the growing demand.

Better Supply and Demand

Planning With NetSuite
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NetSuite Supply and Demand Planning helps businesses
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balance supply and demand to ensure that they can fulfill 
customer orders while minimizing excess inventory. Part of an
integrated suite of business applications, NetSuite Supply and
Demand Planning helps increase forecast accuracy, improve
product availability, minimize inventory carrying costs and reduce
production delays. NetSuite Demand Planning predicts inventory
needs, based on factors such as historical demand, seasonality,
growth and profit opportunities and sales forecasts. NetSuite
Supply Planning helps companies determine how best to meet
that demand, generating production and purchasing schedules
and creating the relevant work orders and purchase orders.

Conclusion
The law of supply and demand can provide a useful model for
understanding and determining pricing. It can help determine an
equilibrium price, where suppliers can meet demand without
overstocking, and customers get everything they need at a price
they can accept. However, supply, demand and pricing can also
be influenced by factors that the law of supply and demand
doesn't consider, such as production costs, supply chain
problems and regulations.

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Law of Supply and Demand FAQs

What are wasted
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time laws Automate
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andNetSuite
demand? ERP.
The four basic laws of supply and demand are:
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1. If supply increases and demand stays the same, prices will

fall.
2. If supply remains constant and demand decreases, prices
will fall.
3. If supply decreases and demand stays the same, prices will
rise.
4. If supply remains constant and demand increases, prices will
rise.

What is supply and demand in simple terms?

Supply is the amount of a specific good or service that's available
in the market. Demand is the amount of the good or service that
customers want to buy. Supply and demand are both influenced
by the price of goods and services.

What is an example of the law of supply and demand?

If the price of coffee rises too much, some customers may stop
buying coffee and switch to tea. If the price is too low, the reverse
could happen, causing coffee shops to run out of coffee and lose
potential profits. An equilibrium price would balance supply and
demand, enabling coffee shops to avoid overstocks or shortages.
At the equilibrium price, coffee shops can maintain profitability
while keeping customers satisfied.

What is the basic law of demand?

The law of demand states that as prices rise, customers will buy
the product in fewer quantities. This is often because they switch
to other goods as replacements.

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Law of Supply Defined

How to use the law of supply to make supply and pricing

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